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Bond Valuation Assignment Help

Bonds are a form of long term debt. These are liabilities which represent debt raised by a company from external investors which it vows to pay back in a specific time together with periodic interest payments over the life of the bond. The time span in which a company has to pay back the principal plus interest is called the maturity of the bond. The periodic interest payments are called coupon payments and the interest rate specified in the contract is called coupon rate. The entity issuing the bond is borrowing money from an investor who becomes a lender and bondholder. There are many different types of bonds available to interested investors. Some of the more common forms are fixed coupon bond, floating rate bond, zero-coupon bond, convertible bond etc.

Bond Valuation is a technique of determining the fair value of a particular bond. The theoretical fair value of a bond is the present value of the stream of cash flows it is expected to generate in future. Hence, bond valuation includes calculating the present value of the bond's future cash flows (also called as coupon) and the bond's value upon maturity, also known as its face value or par value. The present value of a bond is obtained by discounting the bond's expected cash flows using an appropriate discount rate. In practice, this discount rate is often determined by reference to similar instruments, if it exists. The valuation process involves the following three steps:

Estimate the expected cash flows;

Determine the appropriate interest rate or interest rates that should be used to discount the cash flows; and

Calculate the present value of the expected cash flows found in step one by using the interest rate or interest rates determined in step two.

P = [C/(1+i) + C/(1+i)2 +…..+C/(1+i)n ] + M/(1+i)n

Where,

P = present market price of bond

C = coupon (periodic interest)

i = required rate of return

n = number of payments

M = Value at maturity (Final value)

Let’s take an example:-

What will be the price of a bond today, which is redeemable in four years for its par value or face value of $100 and pays an annual coupon of 5% on the par value? The required rate of return is 4%.

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